Investors in roll-ups watch stakes go `poof'

Some firms had potential

most destined to fail

March 24, 2002|By Andrew Countryman, Tribune staff reporter.

Before there were dot-coms, there were roll-ups.

Both were 1990s phenomena, propelled by similar visions of fundamental change, dynamic growth and eye-popping returns. Roll-ups aimed to build market-leading companies by piecing together dozens of small, privately owned firms in highly fragmented industries, on the idea that the whole would be more valuable than the sum of its parts.

Yet the roll-up fad spawned many more losers than winners. Most collapsed under their own weight, victims of too-heavy debt loads, bad management, poor integration--or just plain bad ideas.

Still, for investors willing to do some sifting, the roll-up bust presents some opportunities. Dozens of these companies are chugging along with substantial market share in profitable industries. While many are struggling to grow organically or find the resources for more acquisitions, weighed down by sagging share prices, a precious few are doing far better than that.

But it takes some doing to sort out which companies have the potential to perform, like red-hot Career Education Corp. of Hoffman Estates, from those destined to collapse, like Washington-based U.S. Office Products. And it also takes some appreciation of how roll-ups became so hot when the stock market was booming.

"We were in a situation in which people were throwing money at anything that moved," said Matt Crow, a vice president and financial analyst at Mercer Capital Management in Memphis, who has advised companies being sought as building blocks of roll-ups.

"The market of the late 1990s was a land-grab market," he said. "The concept of how much you were paying went right out the window, and that really destroys shareholder value. You can only do that for so long."

Indeed, of a group of 113 publicly traded roll-ups from the 1990s that weren't acquired themselves--drawn from lists compiled by analyst Jeffrey Evans, now at Advest Inc., and New York University researchers--17 have filed for bankruptcy.

Although many of those that were acquired delivered handsome premiums to shareholders, of those that remain standing, 83--or nearly three out of four--were trading below their offering prices on Friday.

Many face a long, hard road back.

Consolidation experts said many of the roll-ups fell into a familiar trap from previous market sensations--after some early successes, more and more financiers saw an opportunity to make money, and as more companies came to market, the quality of the deals, and the discipline of their backers, eroded.

The market became enamored of "poof " roll-ups, in which financiers created companies out of thin air, buying up firms with the fruits of an IPO. Poofs, and other, more measured roll-ups, frequently overpaid for acquisitions, experts say. They dove head-first into industries that didn't offer any real advantage to a big national player over the mom-and-pops.

"Many, many of these industries were not ripe for consolidation," said Adam Fein, president of Philadelphia-based Pembroke Consulting Inc., who has extensively studied business consolidation.

Even in industries that had consolidation potential, experts say, initiators didn't always seek out top-notch management teams, and executives weren't always willing or able to do the dirty work necessary to cut costs and improve efficiencies enough to make the roll-up pay off.

And, to some degree, roll-ups were a victim of the infamous 1990s irrational exuberance, said IPO.com market analyst Kyle Huske.

"People suspended a bit of reality in the hope they could make 700 percent gains in the first couple of weeks of a company's life," she said.

Cooking up success

Not all of the roll-ups and other consolidations churned out in the late '90s, of course, were doomed to failure.

One of the best stock-market performers from the era is Career Education, which operates more than 40 post-secondary campuses, offering courses in visual communication and design, information technology, business studies and culinary arts, including programs affiliated with the renowned Le Cordon Bleu school in Paris.

The company has completed more than 20 acquisitions since its founding in 1994 and has managed consistent revenue and profit growth. Since its initial public offering in January 1998, Career Education shares have risen more than 800 percent.

Although Career Education is included in many lists of '90s roll-ups, analyst Richard Close of SunTrust Robinson Humphrey said one reason for its success is that it really isn't one.

Close said Career Education relies on opening new schools, or expanding offerings at existing ones, as much as acquisitions. It generates substantial cash flow, capitalizes on marketing and advertising advantages from consolidation, and pays attention to the details, he said.

"Career Education has been pretty balanced in its acquisition strategy, but it has managed internal growth as well," Close said. "One reason they're so successful on the financial side is that they know how to manage the business."